Wachtell Lipton recently published the 2023 edition of its 235-page “Takeover Law and Practice” publication. It addresses directors’ fiduciary duties in the M&A context, key aspects of the deal-making process, deal protections and methods to enhance deal certainty, takeover preparedness, responding to hostile offers, structural alternatives and cross-border deals. As always, the publication is full of both high-level analysis and real-world examples. Here’s an excerpt from its discussion of M&A litigation:
Shareholder litigation challenging merger and acquisition activity remains common, and, continuing the trend sparked by the Delaware Court of Chancery’s 2016 Trulia decision curtailing the ability to settle such suits in Delaware by way of added disclosures, the bulk of these merger-objection suits in recent years have been styled as claims under the federal securities laws and were filed in federal court.
Recent reports from NERA and Cornerstone Research suggest that the number of such merger objection suits has significantly declined in the past two years. But these studies only account for class actions, and there has been a shift by stockholders toward filing merger objection suits on an individual basis rather than on behalf of a putative class, potentially to avoid class action filing limitations and disclosure requirements under the PSLRA, and therefore do not necessarily reflect any decline in the number of merger objection suits filed.
Merger objection litigation generally challenges disclosures made in connection with M&A activity under Sections 14(a), 14(d), and/or 14(e) of the Exchange Act and sometimes also alleges breaches of state-law fiduciary duties. The overwhelming majority of such federal suits were “mooted” by the issuance of supplemental disclosures and payments of the stockholder plaintiffs’ lawyers’ fees. Unless the federal courts begin applying heightened scrutiny to such resolutions akin to Delaware’s Trulia review of settlements, we expect this litigation-and-settlement activity will continue.
Lowenstein Sandler recently issued this report on the state of the RWI claims marketplace and how it has evolved since the firm’s 2020 report on RWI claims experience. The report says that there have been some pretty significant changes over the past three years, and that from a buyer’s perspective, those changes aren’t for the better. Here’s an excerpt from the intro:
The most significant change is in how R&W insurers approach claims. While buyers increasingly need access to RWI for claim payments because sellers will not provide traditional indemnification, securing payment for claims has become much more challenging—it takes several years to get paid, the claim process is adversarial and resource-intensive, claim payment values are coming down, and more litigation and alternative dispute resolution (ADR) proceedings appear to be on the horizon.
Our survey also revealed an important and surprising trend about why it is taking so long to navigate the claim process: insurers are digging into the fundamental issue of whether a breach has even occurred and then getting bogged down in how to value the loss that flows from the breach. Policyholders are perplexed and frustrated because they expect R&W insurers to understand the deal, the nature of the business operations, and the risks that were assumed when the R&W policy was sold.
In other words, the RWI claims market is headed in the direction of becoming a commoditized insurance product that does not fit the needs of M&A stakeholders, who expect the RWI policy to function as an effective and responsive risk-transfer solution.
The report makes the point that dealmakers expect speed, ROI and rational commercial behavior and aren’t interested in having to litigate a claim or re-diligence a deal through the claims process, and cautions insurers that an immediate course correction is necessary to ensure that consumers of the RWI product continue to see value in it.
The PCAOB recently issued a report on its review of more than 100 audits of SPACs & De-SPACed issuers, and its conclusions weren’t exactly a ringing endorsement of the performance of SPAC auditors. In particular, the report highlighted shortcomings in auditors’ work surrounding the classification of warrants issued by SPACs, which prompted a wave of restatements in 2021. Here’s an excerpt:
We have observed audits of the public company’s year-end financial statements where engagement teams did not:
– Identify and appropriately evaluate a generally accepted accounting principles (GAAP) departure related to:
Warrants prior to the restatement of the public company’s financial statements, stock compensation, and/or measurement and classification of redeemable shares;
The omission of certain required fair value measurement disclosures in the public company’s financial statements; or
– Identify the significance to the financial statements of the public company’s error in the presentation and disclosure related to the contract assets from contracts with customers.
The report identifies additional financial statement auditing deficiencies, ICFR auditing deficiencies, and other instances of noncompliance with PCAOB standards or rules.
SRS Acquiom recently released its annual M&A Deal Terms Study, which reviews the financial & other terms of 2,100 private-target acquisitions valued at more than $460 billion that closed between the beginning of 2017 and the end of 2022. Here are some of the key findings about trends in last year’s deal terms:
– Transaction values were lower in 2022 relative to the record-breaking 2021 M&A market; lower-middle market targets may have been more attractive for buyers avoiding regulatory scrutiny, with limited financing options, or being mindful of uncertain economic conditions.
– The median return on investment for 2022 deals was 4x, down from 5.2x in 2021 but still higher than 2019 and 2020 levels at 3.4x and 3.5x, respectively. The average return on investment increased to 9.1x from 8.5x in the previous year, owing to the top 5% of M&A deals having high transaction values and ROI.
– Shifting trends in earnout structures resulted in a higher prevalence of earnouts (21% v. 17%) in 2022, increased use of earnings or EBITDA metrics, longer performance periods, and virtually no deals with a buyer covenant to run the business in a way that maximizes the earnout.
– PPAs are nearly universal in private M&A; 94% of 2022 deals included a PPA, predominately via a separate mechanism in the consideration section. More than one in four PPAs used a customized approach for accounting methodology, typically via a calculation worksheet attached as an exhibit.
– 93% of deals had at least one escrow; 52% of deals had at least two escrows (e.g., indemnification, PPA, or other special escrow). The median size of all escrows combined as a percentage of transaction value on deals with an indemnification escrow that do not use RWI was 11.3% and 2.5% for deals with RWI identified, compared to 10% and 0.5%, respectively, for the median size of only the indemnification escrow.
As always, the study contains plenty of interesting information about reps & warranties, covenants, indemnification terms, dispute resolution and termination fees.
At issue in S’holder Representative Services LLC v. HPI Holdings, LLC, (Del. Ch.; 4/23) was an earnout conditioned on the surviving entity signing a customer agreement with specific terms. While the surviving company signed a modified agreement maintaining the customer relationship, the buyer declined to pay the earnout because the specific payment conditions set forth in the purchase agreement were not met, and the shareholder representative sued.
There were two contractual earnout triggers at issue in the case. The first called for payment of the earnout if the buyer entered into a “new agreement” with the customer on substantially the same economic terms as the original agreement. The second trigger required payment if the buyer signed an amendment to the original agreement removing an early termination clause.
With respect to the first trigger, the plaintiff argued that the modified agreement document was a new agreement since it was titled “Agreement to Amend Service Agreement” and because it supplanted certain provisions in the original agreement with the customer. Vice Chancellor Fioravanti was having none of this argument, calling it “a strained attempt to find ambiguity in the title” notwithstanding the document’s structure and function—to modify an existing contractual relationship—and the words consistently used to describe it throughout.
As to the second trigger, the plaintiff argued that if the modified agreement was just an amendment, the earnout payment was still triggered because the amendment removed the customer’s early termination right. VC Fioravanti also didn’t find this argument compelling, deciding that the modified termination provision, which maintained the customer’s ability to terminate on 90 days’ notice but only after a certain date, suspended—but didn’t eliminate—the early termination right. Accordingly, the defendant buyer’s motion to dismiss was granted because the specific criteria necessary to trigger payment under the unambiguous earnout provision were not met.
Hat tip to Michael Levin at TAI for linking to this. Apparently, listed UK companies outside the FTSE 100 can buy shareholder activist protection insurance (SAPI) developed by Volante in conjunction with Marsh in the UK. Volante highlights expertise in mitigation, saying they introduce clients to experts before any activist event, and claims this product is the first of its kind:
SAPI is a true world premiere, no one before us has made shareholder activist risk insurable. We identified a whitespace opportunity in the market and decided to design a product centered around client need. By listening to our partners, many of which are activist experts, we have finessed a niche product.
SAPI is designed to cover the legal, PR, and other professional costs incurred during an activist campaign from receipt of the initial demand, through any proxy fight, and to the conclusion of an activist settlement, including:
Costs The reasonable costs and expenses of investigating, mitigating, and responding to activist demands, including, legal, PR, and other professional/consulting costs, together with proxy advisory costs.
Pre-loss mitigation 5% of annual premium can be invested into mitigation services offered by Volante’s mitigation partners.
Extensions Emergency costs and court attendance costs.
Sub-limits For non-public campaigns, proxy fights, emergency costs, and court attendance costs.
The DOJ has recently commented on rewarding buyers that engage in careful and detailed diligence on a target company’s compliance efforts and address post-acquisition issues promptly and properly. Citing these comments, this Morgan Lewis article argues that the typical risk-based approach to due diligence in cross-border transactions may need to be reexamined:
One thing is clear: maintaining the status quo of using template language, relying on representations or certifications, and conducting post-closing “clean up” carry new risks for investors. Within this environment, it would be prudent for investors and US targets preparing for investment to update their diligence approach—whether checklists, questions, document collection, or deal documents.
The article also points to the Biden administration taking an expansive approach to national security—encompassing topics like corruption, healthcare, biotechnology, telecommunications, public welfare, financial well-being, and climate change—and recommends that buyers consider updating diligence efforts and collecting related supporting documentation on a long list of topics identified in the article, if the goal is to minimize national security risk to any cross-border transaction.
The March-April Issue of the Deal Lawyers newsletter was just posted and sent to the printer. This month’s issue includes the following articles:
– Insights from Experience – Acquiring Public Benefit Corporations
– Private Company Mergers of Equals: A Primer for Companies and Investors
– Sale of Business Non-Competes: On the Way Out?
The Deal Lawyers newsletter is always timely & topical – and something you can’t afford to be without in order to keep up with the rapid-fire developments in the world of M&A. If you don’t subscribe to Deal Lawyers, please email us at sales@ccrcorp.com or call us at 800-737-1271.
In its 2023 M&A Report, WilmerHale recently reported on some pretty unusual trends in adoption rates of common takeover defenses by newly public companies in 2022. Here are some stats, which appear even more unusual in the charts included in the report since they show the consistency in adoption of these takeover defenses in earlier years:
– Classified board – adopted by 83% of IPO companies in 2021 and 46% in 2022
– Supermajority voting for mergers and changes to org documents – adopted by 81% of IPO companies in 2021 and 54% in 2022
– Prohibition on stockholder written consents – adopted by 90% of IPO companies in 2021 and 46% in 2022
– Limitation on stockholder rights to call special meetings – adopted by 95% of IPO companies in 2021 and 76% in 2022
What do they attribute this to? The rough IPO market. Here’s an excerpt:
Despite the decline in takeover defenses among established public companies, most IPO companies continue to implement anti-takeover provisions (understanding that such measures may in the future need to be dismantled). In 2022, however, adoption rates by IPO companies for many takeover defenses declined markedly from historical norms, likely due in part to the unusual characteristics of the IPO market that year—deal flow fell by more than two-thirds compared to the preceding three years; offering sizes were much smaller, and IPO companies had far less annual revenue.
If the depressed IPO market is creating these anomalies, they may continue into 2023. John recently blogged that it’s not looking up for IPOs.
Fox’s staggering $787.5 million defamation settlement with Dominion Voting Systems raises all sorts of profound questions about the 1st Amendment, the role of the press and the impact of increasingly partisan media voices on the future of our democracy. Those are questions that will undoubtedly be pondered by lots of big brains – but hey, this is an M&A blog, so the big question for me is the one addressed by this Axios report – did the Fox settlement just make Staple Street Capital’s 2018 acquisition of Dominion the best PE deal of all time?
The answer to that question just might be yes. Axios says that Staple Street paid $38 million for the company and that this settlement is a pretty staggering windfall for it based on its financial results since the closing of that deal:
Denver-based Dominion will be required to pay taxes on its windfall, plus give a hearty portion to attorneys. But this is still a massive amount of cash for a company of its size.
– Dominion currently generates around $45 million in annual EBITDA, up from $10 million in 2018, according to comments this morning from Staple Street co-founder Hootan Yaghoobzadeh on CNBC.
– In terms of revenue, Forbes once reported that Dominion generated $118.3 million for the three-year period between 2017 and 2019.
That’s nice EBIDTA growth, but it’s a rounding error compared to the impact of the Fox settlement, which on its own represents a 1,972% return on the original $38 million purchase price. So, what’s Dominion going to do with that money? According to the company’s founder, it’s going right out the door to the shareholders. Nice.
While Fox licks its wounds, it can take some consolation in the knowledge that its settlement payment is tax deductible, which according to media reports could result in a tax break for the company of up to $213 million.